THE DEBT-EQUITY CLOCK SAYS IT’S TIME TO OWN EQUITIES
Interesting data out of Morgan Stanley recently. According to their “debt-equity” clock they say it’s time to prefer stocks over bonds. According to MS we are entering the recovery phase after having been in the repair phase of the cycle. During the repair phase balance sheets are tirelessly repaired by corporations, debt is paid down, costs are cut, cash is boosted and ultimately credit expands. MS believes the repair phase is just ending and we are moving into the recovery phase.
Although credit should continue to perform well in this operating environment they are moving to an overweight equities position for the following reasons:
1) Fundamentals - Earnings should rebound more sharply than expected. The steep yield curve should help drive bank earnings.
2) Valuations - Equities are cheap compared to high quality credit.
3) The Quality Disconnect - MS believes there is a quality disconnect. While debt markets have been led by the rally in high quality debt the equity markets have rallied on lower quality names. This has created a value gap which makes high quality equity more attractive to high quality debt.
4) Lower risk in high quality equities – MS believes low quality firms are likely to issue debt and take advantage of their strengthened position to issue debt and equity. This adds another layer of risk to owning lower quality names whose debt has rallied substantially.
Source: MS
I guess I now know why WAL Mart has been seeing a lot of upside volume…
Your topic on Ponzi financing was better documented.
“While debt markets have been led by the rally in high quality debt”
Really? Don’t seem evidence of this (HYG vs LQD; KDP indices; junk mortgage REITs, Treasuries (just kidding!))
Note that Rosenberg disagrees violently with the proposition that high-quality equities are cheaper than IG debt. Here is today:
“We re-ran our regressions with the latest tightening in spreads and breakout in equity valuation and found that U.S. investment grade credit is now priced for 2.5% GDP growth in the coming year (was 2.0% two-months ago) and the S&P 500 is now de facto pricing in 4.8%, which, by the way, is now basis points shy of what it was discounting in the summer/fall of 2007. And, backing out the fair-value P/E from the corporate bond market, and yields have been backing up sizably in recent weeks, we can see that the S&P 500 is now pricing in $85 of operating earnings, which we think will be, at best, a 2013 story.”
Was it a MS analyst that came out last week with a BUY on IBM with a price target of 140? Tops in 2000 and 2007 were 135.
Their clock may be right but I’m pretty sure they have it set for the wrong time zone.